Consumer Spending

Did you know that consumer spending accounts for almost 70% of the overall economy in the United States,¹ and a similarly high percentage in many other countries? With such an enormous impact on economic growth and the strength of a nation, it would be wise to understand more about this vital component of the overall economy. Ready to learn more about consumer spending? Let's get started!

Consumer spending definition

Have you ever heard on TV or read in your news feed that "consumer spending is up", that "the consumer is feeling good", or that "consumers are opening up their wallets"? If so, you may have been wondering, "What are they talking about? What is consumer spending?" Well, we're here to help! Let's start off with a definition of consumer spending.

Another way to think about consumer spending is any purchases that are not made by businesses or governments.

Consumer spending examples

There are three categories of consumer spending: durable goods, nondurable goods, and services. Durable goods are things that last a long time, such as TVs, computers, cell phones, cars, and bicycles. Nondurable goods include things that don't last very long, such as food, fuel, and clothing. Services include things like a haircut, plumbing, TV repair, auto repair, medical care, financial planning, concerts, travel, and landscaping. To put it simply, goods are given to you in exchange for your money, whereas services are done for you in exchange for your money.

Fig. 1 - ComputerFig. 2 - Washing Machine Fig. 3 - Car

One might think a house would be a durable good, but that is not the case. While buying a house is for personal use, it is actually considered an investment and is included in the category of Residential Fixed Investment for the purposes of calculating Gross Domestic Product in the United States.

A computer is considered consumer spending if it is purchased for personal use. However, if it is purchased for use in a business, it is considered an investment. In general, if a good is not used later in the production of another good or service, the purchase of that good is considered consumer spending. In the United States, when a person buys a good that is used for business purposes, they can often deduct those expenses when filing their tax returns, which can help to reduce their tax bill.

Consumer spending and GDP

In the United States, consumer spending is the largest component of the economy, otherwise referred to as Gross Domestic Product (GDP), which is the sum of all final goods and services produced in the country, given by the following equation:

$$\begin{gathered} GDP=C+I+G+NX \\ Where: \\ C=Consumption \\ I=Investment \\ G=GovernmentSpending \\ NX=NetExports(Exports-Imports) \end{gathered}$$

The impact of a recession on consumer spending can vary widely. All recessions occur because of an imbalance between aggregate supply and aggregate demand. However, the cause of a recession can often determine the impact of a recession on consumer spending. Let's examine further.

Consumer Spending: Demand Grows Faster Than Supply

If demand grows faster than supply - a rightward shift of the aggregate demand curve - prices will move higher, as you can see in Figure 4. Eventually, prices get so high that consumer spending either slows or declines.

Fig. 4 - Rightward aggregate demand shift

Consumer Spending: Supply Grows Faster Than Demand

If supply grows faster than demand - a rightward shift of the aggregate supply curve - prices tend to either remain fairly steady or decline, as you can see in Figure 5. Eventually, supply gets so high that companies need to slow hiring or outright let go of employees. In time, this may lead to a decline in consumer spending as personal income expectations fall due to fear of job loss.

Fig. 5 - Rightward aggregate supply shift

Consumer Spending: Demand Falls Faster Than Supply

Now, if demand falls faster than supply - a leftward shift of the aggregate demand curve - it can be due to a decline in consumer spending or investment spending, as you can see in Figure 6. If it's the former, then the mood of consumers may actually be the cause of, rather than the consequence of, a recession. If it's the latter, consumer spending will likely slow as a decline in investment spending usually leads to a decline in consumer spending.

Fig. 6 - Leftward aggregate demand shift

Consumer Spending: Supply Falls Faster Than Demand

Finally, if supply falls faster than demand - a leftward shift of the aggregate supply curve - prices will rise, as you can see in Figure 7. If prices rise slowly, consumer spending may slow. However, if prices rise quickly it could actually lead to stronger consumer spending as people rush to buy goods and services before prices rise even further. Eventually, consumer spending will slow as those previous purchases were, in essence, pulled from the future, so future consumer spending will be lower than otherwise would have been the case.

Fig. 7 - Leftward aggregate supply shift

As you can see in Table 1 below, the impact of a recession on consumer spending has varied during the last six recessions in the United States. On average, the impact has been a 2.6% decline in personal consumption expenditures.¹ However, that includes the very large and rapid decline during the short-lived recession in 2020 due to the shutting down of the global economy as COVID-19 shocked the world. If we remove that outlier, the impact has been only slightly negative.

In summary, it is possible to have a recession without a large, or even any, decline in consumer spending. It all depends on what caused the recession, how long and how bad consumers expect the recession to be, how concerned they are about personal income and job losses, and how they react to it with their wallets.

Table 1. Impact of recession on consumer spending between 1980 and 2020.¹

As you can see in Figure 8. below, consumer spending has a strong correlation with GDP in the United States. However, consumer spending has not always declined during a recession. The cause of a recession determines how consumers will react to a decline in GDP, and consumers can sometimes be the cause of a recession as they pull back spending in anticipation of falling personal incomes or job losses.

It is clear that personal consumption expenditures declined noticeably during the Great Recession of 2007-2009 and during the pandemic-induced recession of 2020, which was a massive and rapid shift left in the aggregate demand curve due to government-imposed lockdowns across the entire economy. Consumer spending and GDP then both rebounded in 2021 as the lockdowns were lifted and the economy opened back up.

Fig. 8 - U.S. GDP and consumer spending. Source: Bureau of Economic Analysis

In the chart below (Figure 9), you can see that not only is consumer spending the largest component of GDP in the United States, but its share of GDP has been increasing over time. In 1980, consumer spending accounted for 63% of GDP. By 2009 it had risen to 69% of GDP and stayed around this range for several years before jumping to 70% of GDP in 2021. Some factors leading to a higher share of GDP include the advent of the internet, more online shopping, and globalization, which has, until recently, kept consumer goods prices low and thereby more affordable.